My Best Investments Are Losers

It's easy to discuss successful investments but far more difficult to assess unsuccessful, money-losing investments. The human mind cannot rationally deal with losing money, so when investors make a bad bet, the immediate response is to sell and resolve never to invest in that particular business ever again. We convince ourselves that by avoiding that company forever, we have learned from our losing investments.

If only it was that simple. As in life, learning from your mistakes often proves vastly more valuable than taking comfort or boasting of your accomplishments. It takes discipline and commitment to look back on your thought-making process honestly to find out where the lapse in judgment occurred. Sometimes, you discover your oversight immediately, in which case you have saved yourself from future financial pain and emotional headache. Other times, you will discover that your research and analysis continued several errors of judgment, in which case you will spend time and effort assessing and learning from each one. Either way, the time spent understanding the nature of your mistakes will prove invaluable in future investments.

Unfortunately, very few investors will take the required time to do this. The ego often gets in the way. What better -- and perhaps easier -- way to erase your mistakes than by quickly trying to recoup by making another investment that you are confident will succeed. Other times, simple laziness gets in the way. Either way, this negligence is vastly dangerous; financial habits can be hard to break if they go unchecked. As we all know, it becomes far more difficult to break a pattern of behavior when it has become habitual or addictive. Poor habits, financial or otherwise, can often be the difference between success and failure.

In investing, it's crucial to understand what constitutes a mistake and what doesn't. After shares of a stock are purchased, a subsequent decline in the stock price does not mean a bad decision has been made. The movement in stock prices is known as volatility, and that is part of the market. An investor should not care one iota if a well-researched stock bought at an attractive price experiences a decline. In fact, that should be welcome news as you now have a chance to buy at an even better discount. An investment mistake is one that results in a permanent loss of capital due to a permanent impairment in that business's future cash flow generation.

For example, consider electronics retailer Best Buy (BBY). Earlier this year, when shares were trading around $19 off from a year-earlier high of $30, I suggested that Best Buy was a worthwhile investment. It was the last remaining electronics retailer thanks to the demise of Circuit City. Even competition from Wal-Mart (WMT) and Target (TGT) wouldn't be detrimental because Best Buy had a vastly wider selection of products, a more knowledgeable staff and comparable prices. Where I made my mistake was underestimating the threat of two other not-so-obvious competitors: Amazon (AMZN)and Apple (AAPL).

Today, Best Buy shares languish at $13 and the company is trying to sell itself to its founder, Richard Schulze. Perhaps Schulze can revive the company, but doing so will require a gigantic shift in market strategy. It can no longer be a big box retailer, selling inventory subject to rapid obsolescence. These issues facing Best Buy are not temporary and, thus, have a permanent effect on the future cash flows of the business. The mistake here was that I failed to grasp that Best Buy's competition was beyond other traditional retailers: Best Buy was now competing with an online market, as well as product companies with their own retail locations. Add to that the fact that retailing is an industry with very low barriers to entry and the only way to compete in a commodity line like electronics is via low prices, and the problem is even bigger.

Even though I never invested in Best Buy, as the stock price continued to drop I became more interested. But as I dug deeper, I discovered red flags that I could not overcome. In the future, I will be better prepared to quickly assess other retailers or consumer-product businesses. For the rest of this month, I will continue to explore other investment fallacies that I have learned either by close observation or by actual experience.

No investor, or individual, gets through life without his or her share of mistakes. But perfection is not a prerequisite for success. Yet the marginal benefit that accrues to an investor who tackles those mistakes can be the difference between a great record and a mediocre one. In baseball, a career batting average of .300 will likely get you into the hall of fame. The difference between a .250 batter and a .300 batter is an additional 50 hits per 1,000 at bats. The potential benefits from making fewer errors cannot be underestimated in baseball, investing, or life.